Rainfall, Windfall: Cloudy with a Chance of Profits

August 1, 2013 03:50 AM
Rainfall, Windfall: Cloudy with a  Chance of Profits


Is volatile weather becoming the norm? The past two growing seasons have certainly made a case for it. Last year brought a once-in-a-generation drought to much of the Midwest. The 2013 planting season brought a mix of cold, rainy weather that resulted in the latest planting season in 20 years and the wettest June in more than 50 years.

While everyone’s heard of the proverbial "million-dollar rain," most farmers don’t think of the weather as an actual marketing tool. However, you can use Mother Nature as a blueprint to help devise a better set of marketing strategies.   

The best place to start is in your own backyard, says Frayne Olson, North Dakota State University crops economist. Just make sure that’s not the only place you’re looking.

"One of the traps farmers get caught in is they will look out their back window and assume what’s happening in their yard is happening to everybody else," he says.

Understanding the relationship between cash and futures can help farmers lock in the best marketing tools, Olson says, and weather often plays a huge set-up role in that dichotomy.

"Weather plays a huge set-up role in the dichotomy of cash and futures."

For example, local weather influences local cash grain prices, but futures prices are more dependent on Midwest-wide weather and other national and global influences.

Seek out anomalies for extra profit opportunities, Olson says.

Last year’s drought, for example, pushed prices higher as much of the Midwest was lined up for below-average yields. "But we were the outlier in the corn crop in North Dakota," he says. "We had above-average yields."

In this example, the marketing tool of choice was a hedge-to-arrive contract, Olson says. He watched farmers flexing this option last fall take in an extra 60¢ per bushel as the cash/futures gap shrank from 80¢ to 20¢.

Tracking local weather conditions is critical, Olson says, but it’s equally important to understand what is happening elsewhere in the Corn Belt and across the globe. "We’re really good at following local supply and demand," he says. "What’s much harder to follow are those things outside of agriculture that still impact crop prices."

The problem with weather forecasting is its ultimate impossibility, says Jim Hilker, agricultural economist at Michigan State University.

Calculate Probability. "If it were not for weather, I would be pretty good at marketing," Hilker says. "That’s why when I talk to farmers about prices, I like to talk about probability distributions."

Knowing that the weather can take any farmer on a wild ride at any given time, Hilker likes marketing strategies such as the grain price options fence. "This allows you to lock in a slightly higher bottom and a slightly lower top," he says.

Puts are relatively expensive pricing tools, but selling the call lowers the cost of the downside price protection without limiting the upside, Hilker explains. Revenue insurance is also important when forward pricing a lot of new crop. Even the best-laid marketing plans can hit the occasional road block, Hilker admits.

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